This site uses cookies to store information on your computer. Some are essential to make our site work; others help us improve the user experience. By using the site, you consent to the placement of these cookies. Read our privacy policy to learn more.

Latest Stories

Benefiting from a Fiscal Tax Year

Corporations eligible to use a fiscal year should
consider it, since preparing tax returns and financial
reports outside an external accountant’s peak times may save
professional fees. Corporations should also consider their
own staff workload when selecting a fiscal year to minimize
overtime associated with the year-end closing and
preparation of financial statements.

Note: Changing to a fiscal year
generally requires IRS approval. However, corporations can
adopt a fiscal year at formation without IRS approval.
Therefore, tax advisers should look carefully at the
decision of whether to use a fiscal tax year when a
corporation is formed.

Use of a fiscal or a
52-53-week tax year may provide a significant tax planning
opportunity for a C corporation and its shareholders. For
example, if a corporation has a January 31 year end and its
shareholders each have a December 31 year end, payments such
as interest on shareholder loans and bonuses to shareholders
can be made late in the corporation’s tax year but prior to
January 31. The corporation can deduct these payments on its
January 31 tax return; however, the shareholders do not have
to report the income until they file their calendar-year
returns, creating an 11-month deferral of tax (although
income tax withholding or estimated tax payments on the
bonuses or interest may offset at least some of this
benefit). However, the related-party rules under Sec. 267
may act to limit the ability of the controlling shareholders
and the corporation to manipulate the timing of deductions
and related income.

Because most businesses tend to
have fluctuations in taxable income from year to year, the
use of a fiscal year can provide a leveling effect by
shifting income between tax years. Salary payments from the
fiscal-year corporation to the calendar-year
employee-shareholders can be postponed or accelerated to
offset the natural fluctuations in business income from year
to year. The use of a fiscal year can also result in
deferral of the taxation of earnings, to the extent that
deductible payments (compensation, rent, interest) are
issued from the corporation to individual stockholders after
December 31.

Example: T owns
C, a C corporation that reports on a January 31
fiscal year end. (C operates a distributorship
and so is not a personal service corporation required to
use a calendar year.) C has historically averaged
$100,000 of business net income, and T has
annually drawn a salary from C of $100,000 so as
to remove all corporate taxable income. However, for the
fourth year of C’s existence, pre-salary income
increased to $150,000. In the fifth corporate tax year,
the business net income declined to $50,000.

If T’s business reported as a
calendar-year entity, the higher fluctuation in income in
the fourth year would push income to above-average tax
brackets, and the lower net income in the fifth year would
result in underutilization of the lower annual tax brackets
available to T or his business. But with a
fiscal-year C corporation, T can time his annual
compensation to balance out the ultimate taxable income
consequences within his individual tax return, as shown in
the exhibit.

In year 4, when the corporate fiscal year-end net income
is greater, T takes only a $100,000 salary within
the fourth individual tax year. The remaining corporate net
income is not removed until January, which defers the
recognition of the compensation to T’s fifth
individual tax year. Then, in year 5, when corporate income
is reduced, the full fiscal year corporate income is moved
to T’s Form 1040 in December to maintain his
historical salary of $100,000.

The preceding example
assumes that the fluctuating salary amounts remain within
the range of reasonable compensation levels. Generally,
within a small corporation, where the employee-shareholder’s
services are a significant factor in the business’s success,
salaries that move in relation to the annual fluctuations in
business income, and on average remain within the reasonable
range of compensation, will not present a problem.

When business net income is increasing annually, the use
of a fiscal year by a C corporation, combined with
compensation to the employee-shareholders that is skewed to
the portion of the corporate tax year following December 31,
can create a substantial and ongoing income tax deferral.

Benefiting from a Natural Tax Year

When
selecting a tax year, corporations should consider their own
natural business year. Many businesses have a cycle, so
certain times of the year are less busy than others. Many
corporations choose a tax year corresponding to their natural
business cycle, which generally ends just after the business’s
highest annual sales period. Year-end financial statements
that reflect the natural business year will generally present
a more liquid position due to lower inventories and the sales
peak just experienced. This may enable an incorporated
retailer, for example, to more easily obtain loans to finance
inventory purchases or business expansion.

Benefiting from
a 52-53-Week Year

A 52-53-week year is an annual
period that varies from 52 to 53 weeks, always ends on the
same day of the week, and always ends on (1) whatever date
that day of the week occurs in a calendar month, or (2)
whatever date that day of the week falls nearest to the last
day of the calendar month (Sec. 441(f)(1)). Under item (1),
the fiscal year can end up to six days before the end of the
calendar month in which the year ends. Under item (2), the
fiscal year can end as many as three days before or after the
end of the calendar month.

Owners use 52-53-week years so
they will have a tax year that always ends on the same day
of the week as opposed to the same day of the year (Sec.
441(f)). While adoption of such a tax year by a new
corporation has never required IRS approval, a corporation
adopting a 52-53-week year must file a statement containing
the following information with the tax return for the year
the fiscal year is adopted (Regs. Sec. 1.441-2(b)(1)(ii)):

1. The calendar month in which the new 52-53-week year
ends.

2. The day of the week on which that year will
always end.

3. Whether the 52-53-week year will
always end on the date on which the day of the week last
falls during the month or on the chosen day of the week that
is nearest to the last day of the month.

The
preferred tax year is generally chosen for management
reasons instead of tax reasons. For example, many retailers
use a 52-53-week fiscal year because each month generally
has the same number of selling days and Saturdays from one
year to the next. This makes comparisons to prior year
amounts easier and more meaningful.

Nevertheless,
the use of a 52-53-week year can provide significant tax
planning opportunities for a C corporation and its
shareholders. For example, if a corporation elects a tax
year ending on the last Sunday in June but its shareholders
each have a December 31 year end, payments such as interest
on shareholders’ loans and bonuses to shareholders can be
made late in the corporation’s tax year but prior to year
end, creating a deferral of tax. However, required income
tax withholding or estimated tax payments may offset at
least some of this benefit. Furthermore, the related party
rules may limit the ability of the corporation and its
controlling shareholders to manipulate the timing of
deductions and related income.

EditorNotes:

Albert B. Ellentuck is of counsel with
King & Nordlinger, L.L.P., in Arlington, VA.

Among CPA tax preparers, tax return preparation software generates often extensive and ardent discussion. To get through the rigors of tax season, they depend on their tax preparation software. Here’s how they rate the leading professional products.

The package includes final regulations, guidance on how to calculate W-2 wages, a safe-harbor rule for rental real estate businesses, and new proposed rules on the treatment of previously suspended losses.

Don’t get lost in the fog of legislative changes, developing tax issues, and newly evolving tax planning strategies. Tax Section membership will help you stay up to date and make your practice more efficient.